Teacher Pensions Blog

We get it. Pensions can be a complicated topic. But the teacher workforce is too large--and too important--to ignore how well today's retirement plans are meeting their needs.

To help teachers and the general public understand how pensions work, we created a simple, 3-minute video explaining how teacher pension plans work and how they affect millions of public school teachers.

When they signed-up, teachers were promised a pension when they retire. It was part of the deal. But since states have long-ignored their fiscal obligations, pension funds carry significant unfunded liabilities, threatening their ability to fund teachers’ retirement. It makes sense that teachers, and particularly their unions, want to fight back.

But is fighting to protect the existing pension plans in perpetuity the right thing to do?

On Saturday at the National Education Association’s (NEA) Leadership Summit, John Jensen, the Vice President of the Retired Executive Council of the NEA, will lead a break-out session on the “bogus” research attacking teacher pensions and how to defend against it. And in the interest of transparency, we, as well as The Laura and John Arnold Foundation (one of our funders), are among Jensen’s list of “faux researchers.”

If his presentation at the Summit last year is any indication, this session will deal less with research and more with ad hominem attacks. But ignoring the evidence will only serve to harm the very teachers he seeks to protect.

Nowadays teachers do not spend the whole of their professional lives in schools. In fact, the most common years’ of experience for teachers nationally is around 5 years. This has serious retirement implications. Since the majority of state pension plans have overwhelming amounts of debt, states have raised their vesting periods as a cost savings measure. All of this means that at least half of new teachers will not ever receive a pension. And, when they do leave the classroom it is only with their own contributions (often earning very little interest), and many teachers don’t even earn Social Security during their tenure.

States are crippled with teacher pension debt. To be clear, this is not teachers’ fault. Rather, states didn’t make sufficient investments and the funds often had lackluster returns. As a result, districts on average now spend $2,500 on employee benefits. And pensions alone comprise over $1,000 of that. This means that – baring a huge reform – teachers today are paying for the pension of current retirees even though they themselves will likely never receive a pension anywhere near as generous when they retire.

Since most teachers won’t teach for their entire career, a defined contribution plan such as a 401k or 403b would actually produce a more valuable retirement benefit. Due in part to cross-generation subsidization, it takes a 25-year-old teacher decades before her pension is more valuable than her own contributions, or what she could have earned from a DC plan. Pension plans are designed to convey valuable benefits on people who stay in their careers for thirty years or more. And they do. But, they do so at the expense of the majority of teachers.

Pension funds work kind of like insurance, where one group subsidizes the other. In the case of teacher pensions, the contributions of short-term teachers’ pay for the retirement of longer-term ones. This would be ok if all teachers taught long enough to reach the point when their pension is sufficiently valuable. But that isn’t the case. Instead, short-term teachers incur significant financial losses to pay for pensions that they will never receive. A recent analysis of the massive pension fund in California (CalSTRS), reveals that roughly two-thirds of California’s teachers are pension “losers” because of this. Additionally, newer teachers have the burden of paying for past pension debts.

Despite what the NEA says publicly, the fact is teacher pension systems are in need of reform to better meet teachers’ retirement needs. Shifting to provide new teachers with the option of investing in a 401k for their retirement won’t solve all of the teacher pension woes. The question remains of how will states pay for their existing pension obligations. That will likely take a lot of innovative thinking and some difficult sacrifices from taxpayers, and likely teachers themselves. But to be sure, new teachers shouldn’t have to shoulder the pension costs of retired teachers, particularly when the funds may not be around to support them when they leave the classroom.

Over the last 20 years, per-pupil spending has more than doubled. Alarmingly, however, school district spending on employee benefits grew even more quickly. Now, over 22 percent of per pupil spending goes toward benefits payments. In other words, on average 20 cents of every dollar a district spends goes to teacher pensions and other benefit obligations.

As shown in the graph below, the average district per-pupil expenditure on benefits increased from $763, or approximately 15 percent of all spending in 1992 to $2,524, or 22.9 percent of district spending in 2014. The increased district spending on employee benefits eats away at teacher salaries and other education investments.

The current structure of teacher pensions are responsible for a lot of the increased spending on employee benefits. In fact, over $1,000 per pupil is spent nationally on teacher pensions. States, and to a lesser extent districts, have spent decades kicking the can on their pension obligations. And as a result many pension funds now carry billions of dollars in unfunded liabilities forcing them to allocate more money to pay off their debts. Without a corresponding increase in the overall education budget this necessarily means that benefits eat away at other education spending.

Should public charter schools be allowed to opt out of state-run teacher pension plans?

There are strong arguments in favor of letting charter schools opt out. Most charter school teachers would be better off in more portable retirement plans. And charter schools tend to be new, so it might be unfair to ask them to pay off the debts of the old system.

Still, if charters are allowed to opt out, that puts added pressure on traditional school district budgets as they’re forced to take on proportionately larger shares of state pension legacy costs. As the charter sector has grown over time, and as pension debts eat up a larger and larger share of school spending, the charter school pension question has been bubbling up. It’s even played a small role in the debate over the nomination of Betsy DeVos to serve as the U.S. Secretary of Education.

As my colleagues Bonnie O’Keefe, Kaitlin Pennington, and Sara Mead noted earlier this week in their slide deck analyzing the education landscape in Michigan, DeVos’ home state of Michigan has one of the nation’s largest charter sectors, with more than 40 charter school authorizers and 10 percent of its students attending charter schools. Michigan’s charter school sector is also unique in that 71 percent of its charters are run by an Education Management Organization (EMO), which is a for-profit operator of public schools.

Although DeVos has been personally maligned for Michigan’s large for-profit charter sector, one thing that’s been missing from the debate is that Michigan’s EMOs are exempt from the state teacher pension fund. That means Michigan’s EMOs get to avoid paying a share of the state’s pension legacy costs, and in the process, they’re playing a small part in exacerbating the pension debt problem for all other Michigan public schools.

How big of a problem is this? In order to separate fact from fiction, here are six things to know about charter schools and teacher pensions nationwide, with Michigan as an example:

Most charter schools already participate in state teacher pension plans. In the majority of states with charter school laws, charters are required to participate and, consequently, they’re paying a share of pension debt costs. In Michigan, all the nonprofit charter schools participate, while the EMOs do not.

Most charter school teachers who do participate in state pension plans are getting a raw deal. They’re paying for debt costs that they did not create, in a retirement system from which they won’t benefit. Those charter school teachers, including those working in nonprofit charters in Michigan, should be asking why they’re being forced into such a system when they could have something that better meets their needs (see here for examples).

Even in voluntary states, charter participation varies widely. A 2011 report for the Fordham Institute found that, of the 16 states that allowed charter schools to choose whether or not to participate in the state pension plan, participation ranged from 23 percent in Florida to 91 percent in California.

Pension contributions are determined on a statewide basis. We’re talking about state pension debt here. Just because the charter sector grows in any given city does not mean it will dramatically alter the dynamics of an entire state’s pension plan. Looked at from the statewide perspective, charter school market share is still relatively small. For example, it doesn’t really matter for pension contributions that charters enroll 53 percent of the students in the city of Detroit. Michigan runs a statewide teacher pension plan, so what matters is that approximately 7 percent of students statewide are enrolled in EMOs that do not participate in the pension plan.

Traditional public schools do face higher contributions when charters opt out of state pension plans, but those costs pale in comparison to overall state pension debts. In Michigan, for example, participating school districts are required to pay 13.9 percent of each teacher’s salary toward unfunded pension liabilities. If Michigan forced EMOs into the system, that would broaden the total payroll base in the pension plan by roughly 7 percent*, meaning the contribution rate could also fall 7 percent, to 12.9 percent of salary. But consider this in perspective. Michigan’s contributions towards its unfunded liabilities have increased 143 percent over the last 10 years. The state’s charter sector has played only a tiny role in that increase.

Charters may be an easy target, but they are not the cause of, nor the solution to, state pension debts. Although states vary in how they plan to pay off their pension debts — whether the money is coming out of state or district budgets — all states calculate their debts as a percentage of teacher salary.** That is, states think of their pension debt obligations as a percentage of the total salary base of all members of the plan (mostly teachers but other district staff may be included as well). This arrangement is sensitive to the number of employees in the system and the salaries they earn. Pension debts must be spread over fewer workers if a recession hits and districts hire fewer teachers, if charters expand and are allowed to opt out, or simply if school enrollment declines due to demographic factors.

In this case, the problem is not charter schools, it’s the fact that states accrued large pension debts and are using an unfair funding mechanism to pay them off. Unfunded pension liabilities were not caused by students or teachers, and legislators should not expect schools to bear their full burden. Given that state politicians caused these problems, the states —not school districts, and certainly not charter schools — should bear the budgetary burden of fixing them.

*I’m making some broad assumptions here about student/teacher ratios and salaries in Michigan’s EMOs, but given national data, I think these estimates are probably conservative on the high side.

**Some state governments take full responsibility for teacher pension plans, other pass all the costs on to local school districts, while others split the responsibility between state and local governments. Each of those options carries a different set of incentives. Those incentives are worth a separate discussion, but they’re not the subject of this piece.

Back in 2014, we wrote about California Governor Jerry Brown’s plan to increase teacher, district and state contributions to the state teacher pension fund. The California State Teachers Retirement System (CalSTRS) was facing a staggering $74 billion unfunded liability, accrued over years of over-promises and lower-than-expected returns. At the time, we commended Governor Brown for taking preemptive measures to pay down those debts.

As the plan ramps up, it’s beginning to take a toll on district budgets, and it’s worth revisiting what was in that plan. Under Gov. Brown’s proposal, teacher, district, and the state pension contributions will ramp up such that, by 2021, 38 percent of each teacher’s salary will be going directly into the pension system. Districts will bear the brunt of this burden. Their costs will jump from paying 8.25 percent of each teacher’s salary in 2014 up to 19.1 percent in 2021.

The effects of Gov. Brown’s plan are starting to be felt in districts across the state. Earlier this month, San Diego Unified School District announced major, pension-induced budget cuts. Voice of San Diego showed the district had paid $75.7 million toward CalSTRS contributions in 2014. This year, with the contribution percentage jumping to 12.58%, the cost is nearly $124 million, and SDUSD is feeling the squeeze. They’re not alone. As districts take on the majority of the contribution increases, money that could otherwise go toward raising teacher salaries, combating teacher shortages, hiring classroom aides, or expanding pre-k will instead go to paying down the state’s pension debt. Over time, districts may get less money from the state as well, as the state’s share of the contributions also ramps up.

At the same time, teachers may feel frustrated. They may not know that district contributions are going up; after all, those contributions don’t show up on their paystubs, even if they are real costs born by their employer. Yet, teachers’ own contributions went up as well, and those are already showing up as lower take-home pay.

Perhaps worst of all, most of the new money is going to pay down pension debts, not to fund actual teacher retirement benefits. Most California teachers will never see a benefit from their pension system and are simply subsidizing past debts and the retirements of very long-term veterans.

Existing legislation ensures these district contributions will continue to rise through at least 2021. This is better than ignoring the mounting debt, but it will dramatically hinder school in their ability to serve teachers and kids. Instead, California teachers may want a refund.

Collectively, states face $1.4 trillion in unfunded pension liabilities, and $500 billion of that is due to teacher pension debt. As much as we here at Teacherpensions.org would like to shift the conversation to whether or not those pension plans are providing adequate retirement security to all teachers—they generally are not—the reality is that state legislators are much more focused on these large budgetary pressures than they are on retirement benefits for individual teachers.

Annually, states are contributing roughly $37 billion* a year just to pay off teacher pension debts, and those pension debts can’t just be wished away. So, what are the choices states face in dealing with those large pension debts? I see at least six options:

1.Wait and see. This is the approach most states are taking. They’re essentially hoping that stock market returns will surpass their assumptions and allow their investments to grow enough to wipe away their debt. This hope isn’t without precedent. Around 2000, at the end of the dot-com boom in the 1990s, the typical pension plan was fully funded (see Figure A here). Unfortunately, state legislators acted as if those market returns were the norm, and they proceeded to dramatically cut contributions and enhance employee benefits retroactively.

Those decisions turned out very badly, and I suspect states are making similarly short-sighted mistakes today. Remember, the $500 billion figure above already assumes states are able to hit their investment rate targets of 7.5 or 8 percent a year. States need to hit those targets every year or else their debt piles will grow even more. Basically no credible analyst thinks this is possible anytime soon, but states will continue to hope they can miraculously escape the pain.

The downside of the wait-and-see approach should be obvious. States and school districts are already dedicating increasing shares of their budgets toward pensions, and any stock market crash, or even just a few years of mediocre returns, will only accelerate that trend. Plus, as plans have increased in size, they’ve become even more susceptible to large swings in the stock market.

2. Restructure the debt. This is another common choice for states. Rather than dealing with the debt, they might just change the time period for when they have to pay it off. Imagine you have a 30-year mortgage on your house. After a couple years, you decide that you can’t meet the full monthly payments, so you take out a 30-year loan on those monthly payments as well. This may sound crazy, but some states do this automatically every year, while others revisit their decisions every couple years and promise to really, seriously, finally, make their payments this time. Generations of politicians have all made the same promises.

3. Cut benefits. State pension debts are promises to retirees, and it might be tempting for some state leaders to try to trim the debt by cutting those promises. That could involve anything from reducing cost-of-living adjustments given to retirees or altering the formula for current workers. While these approaches could lead to large cost savings, and there are some approaches that would only affect teachers with many more years left in the profession, as a general rule I would caution states against cutting benefits. There's big financial gain, but large potential downsides in terms of political, legal, and moral backlash.

4. Offer pension buy-outs. Another way to reduce pension liabilities is to get people to voluntarily opt out of them. By offering upfront cash payments, states may be able to induce some teachers to switch from the current defined benefit plan, with large and unpredictable debt costs, to more predictable defined contribution plans. When presented with such a choice, we don’t know if teachers would make smart financial decisions, or if there might be some perverse incentives for people who take up the buy-out offers, but judging by places that have tried similar efforts, there might be large portions of teachers who would prefer upfront cash payouts over long-term pension promises.

5. Issue bonds. State pension debt is flexible, and legislators have a tendency to shirk their long-term pension funding responsibilities in favor of other, more immediate spending priorities. That pattern has led us to where we are today, where states have over-promised and under-saved. States could decide to commit themselves to a more tangible payment schedule by issuing “pension obligation bonds.” Bonds would force states to make regular payments, and, in theory, they offer the state a way to reduce their obligations. After issuing bonds paying interest at, say, 5 percent, they would invest the proceeds and hope that they could earn a higher rate of return over the life of the bond.

The theory behind pension obligation bonds hasn’t always worked, especially over shorter time periods, when returns can be more volatile. States have used pension obligation bonds as a way to escape temporary budget problems, but the basic problems resurface if the state isn’t disciplined enough to continue making pension contributions. And with the stock market around all-time highs, now might not be the best time to invest billions of dollars in new money.

6. Find new revenue. This is perhaps the best option, but I haven’t seen many states try it (with some exceptions). There are lots of choices here, though. My personal preferences would be for states to impose a new consumption tax on something that’s bad for the world, like gambling or carbon emissions or sugar or cigarettes, but states could also impose a special tax on millionaires or rent out some state asset (like highways or parking lots). The specific solutions would vary by the state, but the important thing would be finding a new source of revenue to pay off pension debts.

There are better and worse choices on this list, and states could choose to pursue more than one of them at a time, but regardless of which path a state chooses, none of them are permanent solutions unless they’re also paired with broader structural changes that close existing defined benefit pension plans to new members. In return for their (higher) contributions, it seems reasonable for taxpayers to insist that the state come up with a reasonable plan to prevent the state from accruing these debts ever again.

Unfortunately, most state leaders are letting their debts prevent reforms that would be good for teachers. Instead, they’re using the new generation of teachers to pay off past debts. That’s not fair, and it’s not the way pensions are supposed to work, but that’s the bet most states are making today.

Ideally, states would adopt a package of reforms that accomplished three things simultaneously—pay down existing debts, prevent the state from accruing similar debts in the future, and provide all teachers with adequate retirement savings. That sort of bargain would provide relief to taxpayers, give confidence to existing teachers and retirees that their benefits are safe, and put all new workers on a path to a secure retirement.

*To get the estimate of $37 billion, I took the $313.4 billion schools and districts are spending on salaries and multiplied it by the 12 percent of salary the average state is spending on pension debt costs. That’s not a perfect estimate because the pension costs quoted here represent a state average, not the average across all teachers nationwide, but it’s a reasonable approximation.

The conventional wisdom on saving for retirement offers two key principles. First, you should start saving early. And second, the wealth of your savings is directly related to how much you contribute to them. In fact, these two ideas form the basis of a Prudential commercial that frequently runs on TV.

For people in most professions the conventional wisdom more or less applies. But, unfortunately, it doesn’t for public school teachers. That is because nine out of ten teachers are enrolled in defined benefit plans that accrue benefits differently, based on state-determined formulas that multiply a teacher’s final salary by her years of experience.

A recent study from the University of Arkansas found that, in the California State Teachers’ Retirement System (CalSTRS), nearly two-thirds of entrants into the teaching profession are pension losers. That is, the majority of California teachers will either be ineligible for a pension or the pension they do qualify for is not worth as much as the money they themselves contributed to the overall pension fund.

This happens because most of the teacher’s own contributions, and the contributions made by the state on her behalf, actually subsidize the pension of more veteran teachers. It’s not until teachers stay in the classroom for a very long period when the value of her pension finally surpasses the value of the contributions.

The graph below illustrates the value of a teacher’s benefit (what pension plans refer to as the “normal cost” of benefits) broken down by entry age and longevity. It shows that less experienced teachers provide a considerable subsidy for those teachers who last in the profession longer. This pattern holds regardless of the teacher’s age when she enters the profession, although teachers who begin their careers at later ages earn a positive benefit after fewer years of working. Note that California teachers technically qualify for some pension after only 5 years, but even reaching that milestone does not protect against many more years of teachers cross-subsidizing more experienced veterans.

Source: Robert Costrell and Josh McGee, “Cross-Subsidization of Teacher Pension Normal Cost: The Case of CalSTRS,” University of Arkansas College of Education & Health Professions, October 24, 2016.

This happens because how much a teacher puts into the pension system does not determine how much she gets out. As a result, teachers do not qualify for much in the way of pension benefits until late in their careers, as they near retirement age. Thus, state pension systems (as illustrated above) are extremely back loaded and shorter-term teachers are subsidizing the retirement of teachers who stay their full careers.

This cross-subsidization presents a number of problems. The system lacks transparency, and teachers may not realize how much is being contributed on their behalf or how the system creates these cross-subsidies. The system overall may look “cheap,” but it might be obscuring the fact that some portion of teachers will receive quite adequate benefits, while most teachers get much less. Also, the problem of cross-subsidies is compounded over time as teachers enter and leave the profession, contributing to cross-generational pension liability problems. And perhaps the biggest problem is that more than half of teachers are “pension losers” whose pensions have been compromised by this back-loaded cross-subsidized system.

Defined contribution plans such as a 401k or 403b account don’t have these problems. Under those types of plane, a worker’s retirement benefit is directly related to how much the employer and employee contribute to it, and how much those contributions grow over time. Those types of plans also avoid the problem of back-loading and therefore employees do not, in effect, have their retirement savings diminished if they leave the profession before reaching retirement age.

The graph below illustrates the value growth of multiple kinds of retirement plans. The data assumes a teacher who entered the workforce when she was 25. It’s clear from this graph that the retirement savings of the majority of teachers today would benefit considerably if their state offered a DC or a cash balance (CB) plan instead of their traditional pension. In fact, the DC plan provides a teacher with greater retirement wealth except for the very few teachers who spend their entire career in the classroom in the same state.

To better serve teachers’ retirement needs, states should at least provide newly hired teachers with the option to avoid the traditional state pension system, instead choosing a more portable defined contribution plan. This would be better for teachers and help keep states from continuing to add to their burgeoning unfunded pension liabilities.